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Latest Fund Manager commentary:
April was a weak month for Global credit markets. Doubtful investors and risk-averse traders remained largely on the sidelines as cash spreads widened and CDS indices showed heightened volatility. The iTraxx Main and Markit CDX indices both managed to tighten somewhat, towards the end of the month, unlike iTraxx Japan, where widening was driven more by domestic technicals (skew trades) and fundamentals (BoJ under pressure, tax hike debates).
There are renewed concerns on the Eurozone debt crisis: Spain, having plunged into a second recession, was downgraded by two notches to BBB+ (neg outlook) by S&P, while banks remain under pressure: all of which prompted a flight to quality.
Austerity has shown its limitations, as with the recent Dutch government resignation, but also in relation to US and Japanese growth and equity markets - both performing better than the more disciplined UK. The earning season offers positive surprises for industrials, supporting sentiment, but this is not translating into higher guidance for the coming quarters. In parallel, with Europe already lagging other markets, credit condition evolution is also hugely varied from one country/region to the next,, and improvements are largely being fed by temporary LTRO measures.
The IMFs announcement, at the end of April, of an increase in its funding facility, is a positive, although underlying lenders are less engaged than in former deals.
Unsurprisingly, investor support was stronger for Australian, Canadian, and Japanese credit markets, given their stronger economies, or, at least, expected to be in the short-term (public & private investment in Japan, leeway for accommodative policy in Australia - confirmed by rate cut in early May, balance of hope & threat in Canada):
In Japan, current market strength faces structural issues that need to be solved (ageing consumers, public debt, nuclear shut-down).
In Canada, recent comments from the Governor of the Bank of Canada, and the very solid March employment figures, could indicate that the Bank is ready to start tightening policy in September. However, this is tempered by softer US manufacturing and employment data, plus falling commodity prices. Meanwhile, the earnings season has started without any major surprise.
In Australia, the business confidence index fell quite sharply in April with business capex intentions for Q1 12 showing a third consecutive decline. Another negative relates to the fact that this is mainly off-site “modular” construction (build aboard), so the transmission mechanism of capex, to the broader economy, is far less effective than for mining, for example. Elsewhere, consumer confidence remained generally flat. Inflation figures are well contained at the bottom of the target band, allowing the RBA to cut interest rates by 50bps just after April month end, in order to boost growth.
In the US bucket, we reduced some European-based credits in favour of short duration high yield positions and attractive new issues in the primary market. The USD portfolio is positioned to benefit from a slow growth economic backdrop, with a conscious effort to out-yield the performance indicator.
In the Euro portfolio, we started the month with a more negative bias on the credit market, worried about the contagion risk from Spain. Indeed, newsflow advocated a reduction of risk and, therefore, we were net negative on credit, especially financials. We moved less negative during the last week of the month, taking into consideration the strong technicals of the Euro credit market. We finished the month of April slightly underweight Euro credit, against our performance indicator, and have decided to maintain this positioning amid the still uncertain environment.
In GBP, we reduced our exposure to Sterling-denominated Italian corporate bonds early in the month, as peripheral volatility returned. In addition, we added some insurance paper and decreased the duration. The Sterling portfolio remains overweight in credit spreads, although we expect some volatility as some concerns around peripheral debt are re-visited.
Concerning the other credits, we maintain no exposure to expensive Japanese cash markets.
The strategy of the Canadian portfolio remains conservative, with low exposure to high beta names.
In a context of higher uncertainty surrounding China’s outlook, we decided to unwind our CDS iTraxx Australia position replicating the Australian market.
In April, the overlay allocation was positioned to benefit from an overall weakness in Europe, due to French elections and Moody’s expected financial downgrades.
We increased the long CDX, short iTraxx Main, and we closed the replication index on Australia, which is often quite correlated to the iTraxx Main.
As we anticipate increasing volatility in Europe, we may take some profits on the non-directional trades in the coming month, while keeping a short position in Europe.
We expect iTraxx Japan to correct a recent widening due to heavy skew trading.